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Urea market rigged?

December 23, 2012

A two-member committee of the Competition Commission of Pakistan has come up with evidence on how the urea market has been rigged by a few players.

It has asked the commission to “initiate proceedings against producers for abusing their position to unreasonably and unjustifiably increase urea prices.”

The committee was formed to look into unprecedented 86 per cent price hike (from Rs850 to Rs1,580 per bag) by all the manufacturers, citing gas shortage in 2011 and its impact on the industry.

However, according to the report, gas curtailment had impacted only 27 per cent of the total urea manufacturing capacity in the country during that period. The rest 73 per cent was un-affected and provided no apparent justification for such an unreasonable increase in price. But still, they followed, what they called ‘market trend’, and increased the price to a level that had no earlier parallel.

The report noted that the manufacturers not only increased price at will but also refused to pass on the benefit of government subsidies to the farmers.

On the basis of this increase, as proven by the profitability analysis of the report, the profits of manufactures went significantly higher as compared not only to their own profits in previous years but also compared with average in other industries.

In particular, both plants of Fauji Fertilisers, which were not significantly impacted by gas curtailment, registered profits before tax of over Rs49 billion in 2011 (Rs33 billion for FFC and Rs16 billion for FFBL). This amounted to twice the profits for these undertaking in the preceding year.

While Engro’s old plant was a beneficiary of price hike due to insignificant effect of gas curtailment, its new plant was impacted.

Despite that, the profit before tax for 2011 was Rs6.9 billion as against Rs5.2 billion of 2010 notwithstanding the fact that financial costs and depreciation charges for new plant amounted to over Rs10 billion in 2011 as against Rs2 billion in 2010, the report says.

The report also notes that benefits of subsidies were not passed on to the growers. The federal government had given subsidies of more than Rs77bn to urea manufacturers in the last three years (2008-11) in the form of reduced price of feed stock gas as against the price of fuel gas. While this concession was meant for urea to be made available to growers at cheaper rates, there was no sign of growers benefiting from regular high price hikes.

The urea producers reported that the amount of subsidy on feed stock gas per bag of 50kg is Rs325. However, as per the finding of the enquiry committee if feed gas is considered at the rate at which fuel gas is provided to the fertiliser industry, the subsidy works out to be Rs424 per bag of 50kg.

If subsidy is calculated considering the rate at which gas is supplied to other customers, the subsidy per bag would be over Rs500 per bag of 50kg. With the amount of profits being made by the fertiliser manufactures, the subsidy, if at all, has to be offered, it should rather be offered directly and in targeted manner.

Taking all the above factors into account, it appears that the abnormal price increase  by all the manufacturers at the same time was unjustified. Where factors such as economies of scale, operation efficiency, innovation and impact of gas curtailment varied from one urea producer to the other, the manufacturers increased prices at the same time. This increase is unmatched in any other period of industry’s history, .the report maintains.

Elaborating, the report points out that a few large producers occupy the market: there are a total of seven producers and if one considers manufacturers of the same group as one, there are only three players in the relevant market. Even if one is to assume that such an understanding is non-existent it is worth noting that three groups (Fauji Fertiliser, Dawood-Hercules and Engro group) collectively hold 84 per cent of the total urea market.

Analysis of the price increase patterns indicate that Engro group is always the price leader despite having a lower market share.

Generally, two players appear to dictate the domestic urea price and both have benefited tremendously by the recent price hike as detailed in the profitability analysis. The report exposes the ‘collective dominance’ of the few producers   in the country’s urea market.

“As urea is a key input in agriculture and is also an essential commodity, it directly impacts each stage of supply chain in the agricultural sector and indirectly all markets. The costs of doing business, entry and growth in all these markets have been severely affected by anticompetitive practices in the fertiliser market.”

As stated above, it is reiterated that taking into account all the factors, such as gas curtailment, input costs, subsidies, profitability analysis and government policies, it appears that the huge price hike of 86 per cent in the price of urea was unjustified.